A comment post on ZeroHedge spurred me to check the recent charts of money supply. And lo and behold…

That’s quite a macaroni elbow-move since the summer. And M2 mirrors the action:

I can’t offhand think of what the explanation for this might be in terms of Fed policy. It doesn’t seem to correspond with anything. QE2 was winding down in June, not starting up.

It seems it must have something to do with bank-driven money creation. But its not as if bank “excess reserve balances” at the Fed have been mobilized in any big way:

Unless that little bit of reduction near the end is indeed what is “powering” M1 and M2″. Of course, bank lending need not be powered by the mobilization of Excess Reserves, so the reduction in those balances does not have to correlate with money supply growth. In other words, this is no proof of causality, or even a connection.

I suppose it could be driven by Euro-flight… i.e. into Money Market Mutal Funds and other forms of savings and the like (or alternatively, their switching out of Euros into domestic money pools). That would explain many M2 components, but not M1 itself, which is moving in its own right. Still, the timing matches best for such an explanation (though, curiously, there was zero reaction of such nature to the Greek crisis of the prior year, as evidenced from these charts — but this time could be different).

All of the above is all the more vexing because the CPI has been relatively muted since the spring:

And while I’m not one to give much credit to this particular government data series, one would think the rate of change would head up in some correlation with the money supply — most likely with some sort of lag. There is no evidence for that in the above. If anything, the most recent CPI spike led the money supply data, a truly bizarre result.

So here’s the bottom line: I’m wondering if this is the calm before the storm — the first sign that we might be seeing the fabled, hyperinflationary-precursor move, where the money supply starts to spike — for basically no good reason. Many observers (including myself) have postulated (if not shown historical evidence) to the effect that a market-driven currency collapse/hyperinflation would likely show a spike in money supply data purely as a market move, prior to the reflection of that money supply on consumer prices. In other words, capital flight, or a “flooding home” of dollars held overseas (which consists of 2/3rds of the actual printed currency, by the way, to say nothing of electronic “eurodollars”) would be the proximate trigger to runaway inflation, if not connected to the immediate actions of the monetary authority. The “just desserts” of generationally discrediting one’s currency and financial system, you might say.

You know, actually, there is something that correlates with a money supply spike starting in early summer, and which is pretty supporting of a hyperinflationary-precursor hypothesis…

As I write this, we’re having a classic Atlanta midnight downpour. I can’t help but think the deluge is coming soon in a monetary sense as well.

The definition of inflation is an increase in the money supply. But at present we have a flight to quality into dollars/cash from around the world. Maybe that caused the spike in M2? Gold falling and US Treasury Bonds at record levels are indicating deflation not inflation. Liquidity is the primary objective in the markets. Banks, companies and individuals are “hoarding” cash assets. I think we will see the money supply decrease as more debt defaults as the economy contacts. In the last quarter the loan loss reserves setup by the banks were being recaptured due to less writeoffs and that was premature. The debt overhang will only go away with credit defaults which I believe are coming in all forms of credit. Obviously we have opposite views of the future,i.e.inflation versus deflation. The direction of gold prices will prove who is right. Every asset class falls during a rush to liquidity and a severe contraction in the economy. The dollar soars. Eventually the dollar will depreciate as the central banks respond by printing money. In my opinion we first suffer contraction and then deflation resulting then a response of devaluation of the dollar and hyperinflation. We both end up at the same place!

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